The US-China Trade War and the Global Supply Chain - (Part 1 of 2)

A key objective of the US-China trade war is to contain China’s economic rise and it appears this goal has been realized. During the April-June quarter, China’s GDP grew at 6.2 percent, and in July of 2019, China posted the slowest quarterly GDP growth in over three decades. However, it is worth questioning whether the outcome aligns with America’s other key trade-war objective— reducing America’s trade deficit with China. A recent Bloomberg report highlights that the US goods trade deficit with Chia hit a five-month-high of $30.2 billion in June of 2019. However, after a closer look at the same report, this year’s January-June trade deficit narrowed to a seasonally adjusted $179.8 billion compared to the January-June 2018 figure of $200.4 billion. Taking these two figures into account, it seems that America’s strategic objective of achieving long-term gains at the expense of short-term pain is on track. But what are these long-term gains that the US is seeking to achieve from the trade war?

What is the Trade War really about and what are the triggers?

Put simply, the US-China trade war is about the US administration’s response to China’s aggressive trade practices, namely three oft-cited issues— Intellectual Property Rights [IPR] violations, forced tech transfers, and policy distortions resulting in a competitive advantage to China’s manufacturing sector and its negative impact on job and wage growth in the US.

Now the second, and equally important question: what exactly triggered the trade war? From several perspectives, the trigger has been a potent mix of the following commonly discussed factors:

One issue lies with the politically sensitive issue of America’s ballooning national debt. America’s national debt currently stands at a record high of $22 trillion. For context, in 2018 the national debt stood at 78 percent of GDP in 2018, a level not seen since World War II.

The second issue has been the US’ rising trade deficit and its impact on employment and wages. A trade deficit at low levels of GDP is a sign of a healthy economy– one that buys more goods from abroad than it sells. This grants the powerful position of a ‘buying’ economy. Currently, the US’ trade deficit stands at $621 billion representing about 3 percent of GDP. In effect, the trade deficit levels have stayed in the vicinity of 3-5 percent of GDP since the turn of the millennium, which shows that the trade deficit numbers have not reached any alarming level. As for its impact on jobs and wages, economists were of the opinion until recently that the real issue was the loss of low-skilled manufacturing jobs, which was to be attributed to technological advancements (and not global trade) that reduced labor demand and benefited high-skilled workers. After all, the manufacturing share of US nonfarm employment had been on a steady decline since the end of World War II from a peak of 39 percent to a little below 10 percent in 2015.

That’s how it was perceived, until the US manufacturing sector received, what the economists call the ‘China trade shock’— the gravity-defying growth of China’s manufacturing might. The country raced past the US in 2010 to become the world’s largest manufacturer. Experts deduce the China trade shock could be a contributing factor behind America’s labor-market woes. As a 2013 Crino and Epifani research paper showed, rising global trade North-South imbalances (between high-income and low-income countries) such as the one the US has with China directly led to wage inequality– especially in high-income countries. Several such accounts linking trade deficits with employment issues began to emerge particularly in the US, the most influential being that of the current White House trade advisor, author, economist and strongest proponent of President Trump’s US-China trade policy, Dr. Peter Navarro.

A third proposed factor is the great recession of 2007-2009. Seen from a historical perspective, it is more than a coincidence that the last trade war that the US administration waged was through the Tariff Act of 1930 (a.k.a the Smoot-Hawley Tariff Act) brought about during the Great Depression. It may be a worth noting that times of recession tend to turn economies inward, a trend that we see in the rise of protectionist voices not only in the US, but also in the UK and the EU.

I would like to point out a rather interesting fourth trigger suggested by author and analyst George Friedman: China’s grandstanding and posturing put on display for the benefit of its people proved to work too well for its own good.

Last but not least, the ubiquity and the growing political influence of social media plays a smaller but not an inconsequential role in amplifying the China threat significantly more than what it possibly is.

Repatriating the Global Supply Chain

Previous trade wars, whether the Anglo-Dutch Wars (1652-1784) or the Opium Wars (1839-1860), were fought for control of disparate supply chains. The last trade war – the Tariff Act of 1930 – waged after the economic globalization of the 20th century was about reclaiming one’s position in the global supply chain and so is the ongoing US-China trade war. A premise that finds resonance in Trump Economic Plan, a September 2016 white paper that Dr. Navarro co-authored with the current US Secretary of Commerce. The white paper lists the repatriation of the global supply chain as a chief objective. In a subsequent interview to Financial Times, Dr. Navarro, considered by many as the chief architect of the trade war, explained what the planned push to repatriate the supply chain meant: “It does the American economy no long-term good to only keep the big box factories where we are now assembling ‘American’ products that are composed primarily of foreign components.” Instead, he added, the US needs “to manufacture those components in a robust domestic supply chain that will spur job and wage growth.”

How the China Shock Reshaped the Global Supply Chain

The current shape of the global supply chain looks very different from that of late-nineties when most goods flows were North-North– between high-income countries which largely comprised western nations and Japan – where the US remained a manufacturing leader both in terms of output and MVA (Manufacturing Value Added) as well as the world’s most important manufacturing exports market.

The dizzying export surge of China since the early 1990s post-reforms era, and particularly after its entry into the WTO in 2001, not only displaced the US as the top manufacturer in terms of output (not MVA) but also began to reshape the global supply chain. Between 2002 and 2012, the three leading manufacturers –  the US, China, and Japan – generated 60 percent of the world’s MVA, and during the same period, China doubled its share of the global MVA whereas the US’s MVA share dropped by about 2.5 percent and Japan’s share dropped by about 2 percent (Andreoni, Upadhyaya 2014).  Driven by massive waves of migration from farm to cities, failing state-owned enterprises to private-owned factories and other aforementioned factors, China’s share of world’s manufacturing exports grew from 6 percent in 2000 to 18 percent in 2012. Conversely, the USA’s share decreased– from 18 percent in 2000 to 9 percent in 2012.

To examine the current shape of the global supply chain networks, let’s take an example from the consumer electronics industry that has served as both an important conflict zone and a punch ball during the trade war. In iPad’s global supply chain, Apple Inc. does the design and R&D, the hard drive is designed by a Japanese company, and the other 400-plus components are manufactured in factories located across East Asia. The final product is assembled in China, shipped back to the US, and is distributed by Apple Inc.

Apple Inc. is the chief owner of the brand’s intellectual property rights, which means most of the patents, trademarks and copyrights, gets to keep the lion’s share of the profits, which by some accounts, could go up to as high as 60 – 80 percent or more. It’s not surprising that Apple Inc. continues to rank among the top ten valuable companies in the world by market capitalization. In fact, all of the world’s ten largest companies by market cap are American and half of them are technology companies, a fact that stands testimony to the USA’s global technology and innovation leadership, a position that is being challenged by China’s advancements and R&D investments in emerging technologies like Artificial Intelligence, Robotics, and most notably the one that has escalated the trade war— the 5G wireless-networks technology.

It’s not only China’s fast-growing tech prowess that threatens the USA’s eminent position in the global supply chain, there is another, bigger development that has already begun to influence the flow of goods through the global supply chain— China’s ambitious, multibillion dollar Belt and Road Initiative (BRI). China launched BRI, formerly known as OBOR (One Belt, One Road), in 2013. The initiative consists of two parts: the Silk Road Economic Belt initiative that spans roads and a host of railroad and infrastructure projects stretching from China to Europe, and the 21st century Maritime Silk Road under which the country is building a sea-based network of shipping lanes and ports throughout Asia Pacific.  Essentially, the ambitious BRI envisions the formation of a global logistics, trade infrastructure and transportation network that will have an epochal impact on the global supply chain. As per the latest reports, the initiative has drawn 124 countries and 29 international organizations who have signed BRI cooperation agreements with China, and taken the trade between China and BRI countries to surpass $6 trillion.  It’s not just the expanse and the scale of the infrastructure projects, the BRI also promises to solidify China’s strong presence in the international maritime shipping network — mainland China ports account for 70 percent of the top ports in the world. The Chinese shipping behemoth, Cosco Shipping, operates 150 sea-rail container transportation corridors through 100 ports. In a short duration of five years, BRI has built a larger ports network stretching from Hambantota in Sri Lanka and Port Payra in Bangladesh going all the way up to Djibouti on the Horn of Africa.  A year ago, China bought a majority stake in the Greek port of Piraeus, which has seen a rapid throughput growth and established the port as China’s maritime gateway to Eastern Europe and Africa. While the Chinese administration has been downplaying the buzz around BRI since the start of the trade war, sector observers see it as a move to dominate the global economy with a China-centered trade network, some even likening it to America’s Marshall Plan (1948) that offered assistance to help rebuild Western European economies after World War II.

Needless to say, China’s meteoric rise and growing influence on the global trade and supply chain networks have forced the world’s reigning superpowers to sit up and take notice, and initiate a trade war that sees no signs of ebbing.

The repatriation of global supply chain: Has it begun?

At this point, fallout from the ongoing trade war includes three emerging trends: visible impacts on global supply chain networks, China’s hurting economy, and the negative impact trade war has had on global economy.

One implication appears to be the gradual location shift of US-linked manufacturing, resulting in beneficial outcomes for smaller countries trade economies. With many Chinese manufacturers in tow, U.S manufacturing is moving to other Asian countries that offer better labor costs, production costs and are US allies, such as Vietnam, Thailand, Indonesia, Malaysia and India. Vietnam is the biggest beneficiary, its US-bound exports are up by 28.8 percent year-on-year, and according to a Bloomberg Businessweek article, foreign companies are being seen queuing up at Vietnam’s industrial parks.

Closer to home, the USA’s neighboring countries, particularly Mexico, Canada, and Brazil, have also benefited from the trade war. Mexico and Canada have pushed China down the ranks to become the USA’s number one and two trading partners, while simultaneously raking in increased business from both the US and China.

On the other side, China’s retaliatory tariffs on cotton and soybeans have shown to benefit Brazil, Australia and Switzerland. Additionally, China has expanded trade with African and Latin American countries who have joined the BRI. The US is keeping a close watch on industrial and transshipment hubs in Vietnam, Cambodia, Myanmar and Malaysia to prevent potential rerouting and tariff circumvention of goods, including steel imports originating from China, Taiwan and South Korea.

Another implication is China’s hurting economy. Apart from witnessing the slowest GDP growth of the post-reform period, its main industrial-production indicators are down— during the month of July itself, China’s factory output plunged to a 17-year low, its US-bound exports fell 6.5 percent, the Producer Price Index (PPI) turned negative and Nikkei’s Purchasing Manager’s Index (PMI) contracted for the third month in a row.

Lastly, the possibility of a global recession may turn into a reality. As per the latest media reports, the trade war escalated during the second week of August. On September 1, the US prepares to impose a new 10 percent tariff on $300 billion worth of Chinese goods. China promises to retaliate with ‘countermeasures’; this back-and-forth exchange has triggered yet another stock-market slump worldwide.

Learning from history

The aftermath of the last trade war initiated by the Smoot–Hawley Tariff Act of 1930, initiated a realization that protectionist policies tend to hurt the warring economies as much as they hurt the global trade and other trading nations. In subsequent years, the US foreign trade policy showed a preference for multi-lateral trade agreements, which eventually led to a more globalized world.

Recent events also show that a trade war could end up hurting the global economy much more than the warring economies– a possibility where nobody wins. For the sake of the global economy and its participants, one can only hope that cooler heads prevail.   

Look out for part 2 for continued discussion on the topic of the US-China Trade War and the digitization of supply chain and how it will play a key role in current trade disputes.

Nick Vyas, MBA, EdD
Executive Director
Center for Global Supply Chain Management
Academic Director
MS Global Supply Chain Management

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